Two of Britain's largest engineering and defence contractors locked horns in a merger battle today after weeks of skirmishes that have encouraged investors in both groups to consider backing a combined firm to rival BAE Systems.

VT Group, the defence services provider, today agreed to release financial documents to rival Babcock, despite vowing to fight a bid it described as unwanted and underpriced.

VT Group also dropped a bid for specialist contractor Mouchel to prepare its case against a Babcock merger. "Dropping the Mouchel approach allows us to concentrate all of our efforts on defending the Babcock bid," VT said.

"We still think combining with Mouchel would be a good strategic move and we could come back for them in six months depending on what happens between now and then."

The concession to provide details of the company's finances were seen as a victory for Babcock's chairman, Mike Turner, the former BAE chief executive, who insisted any offer for VT could only go ahead once he was allowed to conduct due diligence.

Babcock has already made two indicative offers in the past three weeks with its latest bid valuing VT at about £1.25bn, or 700p a share. The company, which runs submarine bases for the Royal Navy at Faslane and Plymouth, also made two informal approaches to VT last year, both of which were rebuffed.

Headed by Paul Lester, VT amassed a cash pile in 2009 after selling its shipbuilding interests to BAE Systems. Lester has called Babcock's indicative offer "strategically unsound" and has hinted he might return funds to shareholders as part of its defence against the unwanted approach.

VT's decision to drop its interest in British infrastructure group Mouchel came ahead of an 8 March deadline set by Britain's Takeover Panel for it to make a formal bid.

Babcock, which owns the Rosyth shipyard, has signalled its intention to move away from defence into more lucrative and long-term support services contracts.

According to the firm, a takeover of VT would enable the two companies to cut about £27m off combined annual costs.

About 40% of investors in VT have stakes in Babcock and vice versa. The latest twist in the battle appeared to show that investors were keen for both sides to talk after weeks of uncertainty.

Babcock, which employs about 17,000 staff, put itself in a stronger position to mount a takeover before Christmas, when it offloaded £500m of pension liabilities. Like most engineering groups, including VT, Babcock has a large shortfall in its final salary pension scheme that has become increasingly expensive to close. The company insured itself against future cost rises, giving investors comfort that at least part of the deficit was capped.

Babcock has indicated that it is prepared to offer between 685p and 715p a share for VT. But analysts said that they believed the price should be at least 750p a share, or as high as 775p.

Angela Lascelles, joint managing director at fund manager OLIM, which holds 1.49% of VT shares, said: "Shareholders seem to be looking for at least 750p and I think [VT chief executive Paul Lester's] attitude is, if it is the right price he will accept it. That is my interpretation."

VT's third-largest shareholder, Scottish Widows Investment Partnership, recently said "significant shareholder value could be created" by a merger of the two businesses.